GUEST CONTRIBUTOR POST: Martin B. Robins is a long time corporate attorney engaged in his own practice, as well as an adjunct law professor. In his practice he represents firms of all sizes, from start-ups to multinational corporations as well as individuals, on a wide variety of matters. He has been frequently published in legal journals on various corporate law topics, most recently in the Duquesne Law Review. This post is exclusive to the Governance Center Blog.
By Marty Robins
Much sound and fury resulted from the SEC’s adoption in August of new proxy access rules, intended to improve corporate governance by making it easier to oust poorly performing directors. Embodied in 1934 Act Rule 14a-11, the rules allow large, long-time, minority shareholders access to large public company proxy cards pertaining to director elections.
A legal challenge is pending as this is published, which has resulted in a stay by the SEC in the effectiveness of the rules while the SEC seeks to obtain an expedited resolution on the merits from the U.S. Court of Appeals District of Columbia Circuit.
The stay makes it probable that the rules will not be applicable for the Spring 2011 proxy season, so that companies will not be required to comply during that time. However, companies may voluntarily proceed under the rules for that time, and may “score points” with the investment community if they do so. Longer term, there appears to be a low probability of legal challenges succeeding. Companies to which the rules apply would probably do well to proceed on the premise that they will take full effect after the spring 2011 proxy season. This means not only adjusting procedures to accommodate requested access when and where required, but also reaching out to larger minority holders to address concerns in a manner which avoids challenges. Even in the extreme case of the rules being struck down, such outreach and/or accommodation of minority holders may serve to blunt costly, time-consuming confrontations with them, without significant legal risk.
Even if the challenge(s) are sustained and while they are pending, covered public companies have nothing to lose – at least legally – by allowing access. Even if someone is placed on a proxy card, they are not guaranteed a board seat, but must persuade shareholders of their merits. Under present law, one can pursue a proxy fight to obtain representation on a board (which may prove to be more costly for the company than simply allowing proxy access). While it is certainly cheaper for the shareholder to do so on a company ballot, there is no legal obstacle to minority representation. Substantive requirements for election – and service after election – continue to be governed by state corporate law.
Whether the new rules are good public policy is not pertinent to such challenges; as directed by Congress, the SEC has already decided that it is. The only issue is whether appropriate process was followed, or whether the rules can be said to be “arbitrary and capricious.” Many of the “legal” objections are more in the nature of policy objections as to the nature and agendas of persons expected to utilize the new rules, and not truly to the process around their adoption. There is concern in some quarters that the rules will be utilized mainly by those pursuing social agendas irrelevant to a company’s business. (See Marty’s AOL opinion piece supporting the new SEC proxy access rules.) Many experienced observers downplay such risks, based upon the investment required to obtain rights under the new rules – 3 percent of a company’s shares, which in many cases will require over $1 billion. (See Sept. 22 CFO.com article, “Will New Proxy Rules Pose Board Risks?”)
It is useful to consider actual and potential grounds for challenge:
- In the case that has been filed, the Business Roundtable and U.S. Chamber of Commerce have argued that the procedures around the new rules were insufficient in that they did not involve sufficient consideration of the risks and benefits of such action, specifically that the SEC did not properly address the implications for “efficiency, competition and capital formation”. This argument makes little sense, in light of the SEC having seriously considered some form of this action for nearly 10 years, public comments (made by these plaintiffs among countless others), and the discussion of risks and benefits in the 451-page release containing the actual rules . One can certainly argue whether the SEC made a good decision on the merits, but to claim that the matter was not thoroughly considered or that rules were arbitrarily adopted, defies credibility.
- As a matter of common sense, it is difficult to understand how placing additional names on a proxy card will impair efficiency, competition or capital formation. As indicated in the above-linked CFO Magazine article, and by Fox Business News, institutional investors, clearly motivated by profit, do not share these concerns. Even if these “harms” would result from mandated minority representation on boards, these rules do not have this effect. The suit also emphasizes the costs to companies to accommodate the access, estimated to be in the low seven figures, and states that the SEC failed to consider them. Apart from the fact that there is no support for these estimates, which seem high simply for the printing associated with adding another name to a proxy card and perhaps some bio material to the proxy statement, they were the subject of extensive commentary from the public.
- The fact that the SEC felt that other factors took precedence hardly means that the comments were ignored. If an “access nominee” appears to have little support, one would not expect the incurrence of any costs to oppose that person.
- In this suit, emphasis is placed upon the likely use of the new rules by labor union affiliates who are supposedly uninterested in business prospects. (See discussion on page 5 of the suit contained here.) This clumsy effort to invoke the class warfare themes of 75-100 years ago is not compelling, in that there is no explanation of why unions as shareholders do not share the same economic motivation as all other shareholders. Whatever anyone’s personal feelings about unions, there should be no dispute that they should have the same rights as all other shareholders.
- They are said to be contrary to state, mainly Delaware, corporate law. The argument appears to be that it is solely state law and company bylaws and charters that govern election procedures. SEC Commissioner Troy Paredes makes a cogent argument. He argues that, among other things, the new rules frustrate the intent of a recently enacted Delaware law which permits, but does not require, this action. Apart from the fact that not all public companies are organized in Delaware, this would be a compelling argument if the new rules dictated modification of such procedures or standards for election, but they do not.
There have been for over 50 years, federal proxy rules governing required disclosures, peacefully coexisting with state law. States and companies remain free to set standards for election, i.e. mandating cumulative voting or majority of total outstanding shares.
- The Chamber of Commerce has argued that the “…the SEC has failed to demonstrate a compelling need for this rule-making or how capital markets will be made more efficient by its adoption.” This may be true as to the SEC, but ignores the dictate of Section 971 of the Dodd-Frank law where Congress charged the SEC with promulgating regulations on the topic.